Regulations and the “Too-Big-to-Fail” Problem: Evidence from the Dodd–Frank Act

Before the enactment of the Dodd–Frank Act, firm size was taken into account by rating agencies in determining the credit ratings of banks. Therefore, the “too-big-to-fail” problem was, at least partially, reflected in big banks’ elevated ratings, which are more than justified by intrinsic creditworthiness. What is unclear is whether the bond market still gives an additional discount in yield to big banks over and above the lower yield spread that is already reflected in the elevated credit ratings due to their size. In this study, we examine this question and document a significant incremental yield discount for large banks even after controlling for credit ratings. Furthermore, we find that big banks with lower ratings pay lower borrowing costs than non-big banks with higher ratings. This additional discount, however, mostly disappeared after the Dodd–Frank Act.